Carbon tax or cap-and-trade?

What is a carbon tax or carbon fee?

Pricing carbon emissions through a carbon tax is one of the most powerful incentives that governments have to encourage companies and households to pollute less by investing in cleaner technologies and adopting greener practices. A carbon tax is a fee placed on greenhouse gas pollution mainly from burning fossil fuels. This can be done by placing a surcharge on carbon-based fuels and other sources of pollution such as industrial processes.

A carbon tax puts a monetary price on the real costs imposed on our economy, our communities and our planet by greenhouse gas emissions and the global warming they cause. A shift by households, businesses and industry to cleaner technologies increases the demand for energy-efficient products and helps spur innovation and investment in green solutions.

Under this system, the price to pollute sets the strength of the economic signal and determines the extent to which green choices are encouraged. For example, a stronger price on emissions will lead to more investment in cleaner energy sources such as solar and wind power. And although a carbon fee or tax makes polluting activities more expensive, it makes green technologies more affordable as the price signal increases over time. Most importantly, a carbon tax gets green solutions into use.

Carbon taxes in action

Many industrialized countries have used carbon taxes to discourage fossil fuel emissions and promote clean energy. For example, Sweden has used a carbon tax to reduce greenhouse gas emissions since 1991. Although a suite of other policies has also been used, the Swedish Ministry of Environment estimated the carbon tax has cut emissions by an additional 20 per cent (as opposed to solely relying on regulations), enabling the country to achieve its 2012 target under the Kyoto Protocol. Sweden's carbon tax has been credited with spurring the innovation and use of green heating technologies that have significantly phased out burning oil for heating.

Although some critics claim a carbon tax would damage the economy, Sweden's carbon tax is a hefty $140 per tonne of carbon pollution. Since the carbon tax was introduced, Sweden's economy has grown by more than 100 per cent, and the country recently ranked fourth in the world on economic competitiveness.

In Canada, B.C. and Quebec use carbon taxes as part of their strategies to reduce emissions and encourage investments in energy-efficiency and renewable energy.

What is a cap-and-trade system?

In a cap-and-trade system, government puts a firm limit, or cap, on the overall level of carbon pollution from industry and reduces that cap year after year to reach a set pollution target. As the cap decreases each year, it cuts industry's total greenhouse gas emissions to the limit set by regulation, and then forces polluters that exceed their emissions quota to buy unused quota from other companies.

The government creates and distributes pollution quotas, most fairly through an auction. This creates an incentive for firms to reduce their emissions and be able to sell rather than purchase pollution quotas. Under this system the market determines the price of quotas.

In this way, the emission cap ensures that total pollution goes down and companies are given an economic incentive to find better ways to reduce harmful greenhouse gas emissions and support clean energy.

Tokyo, a city with a carbon footprint larger than many industrialized nations, launched its own cap-and-trade system in 2010. The initiative applies to its most energy and carbon intensive organizations and aims to reduce emissions to 25 per cent below 2000 levels by 2020.

Carbon tax or cap-and-trade?

There is much discussion about whether a carbon tax or a cap-and-trade system is the best way to put a price on greenhouse gas pollution.

The simple answer is that it depends on how each system is designed. The design will determine the environmental and economic effectiveness. For example, how strong is the economic incentive (i.e., the carbon price) to reduce emissions and switch to cleaner energy? To which emission sectors does the system apply? And how are the revenues used? Are they invested in green infrastructure or corresponding tax breaks?

If both approaches are well-designed, the two options are quite similar and could even be used in tandem. The David Suzuki Foundation believes this price should be applied broadly in the Canadian economy, but that it can be done either through a carbon tax, a cap-and-trade system or a combination of the two.

What's important is that the price on carbon pollution provides an incentive for everyone, from industry to households, to be part of the solution. Ultimately, the critical factor in reducing heat-trapping emissions is the strength of the economic signal. A stronger carbon price will kick-start more growth in clean, renewable energy and will encourage adoption of greener practices.

Pros and cons

Both cap-and-trade programs and carbon taxes can work well as long as they are designed to provide a strong economic signal to switch to cleaner energy. However, some differences exist.

Cap-and-trade has one key environmental advantage over a carbon tax: It provides more certainty about the amount of emissions reductions that will result and little certainty about the price of emissions (which is set by the emissions trading market). A carbon tax provides certainty about the price but little certainty about the amount of emissions reductions.

A carbon tax also has one key advantage: It is easier and quicker for governments to implement. A carbon tax can be very simple. It can rely on existing administrative structures for taxing fuels and can therefore be implemented in just a few months. In theory, the same applies to cap-and-trade systems, but in practice they tend to be much more complex. More time is required to develop the necessary regulations, and they are more susceptible to lobbying and loopholes. Cap-and-trade also requires the establishment of an emissions trading market.

A Carbon pricing solution for Canada

A groundbreaking study shows that Canada's economy can still grow by almost 20 per cent over the next decade while the country dramatically reduces its greenhouse gas pollution by about half. The study shows that Canada could take decisive action and still continue to enjoy strong net job growth and other economic benefits. By 2020 Canadians would save more than $5.5 billion each year at the gas pump because of more efficient vehicles, more public transit and shorter commutes.